Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership CHAPTER 15 PARTNERSHIPS: FORMATION, OPERATION, AND CHANGES IN MEMBERSHIP ANSWERS TO QUESTIONS Q15-1 Partnerships are a popular form of business because they are easy to form (informal methods of organization), and because they allow several individuals to combine their talents and skills in a particular business venture In addition, partnerships provide a means of obtaining more equity capital than a single individual can invest and allow the sharing of risks for rapidly growing businesses Partnerships are also allowed to exercise greater freedom in their choice of accounting methods Q15-2 The major provisions of the Uniform Partnership Act (UPA) of 1997 have been enacted by most states to regulate partnerships operating in those states The UPA 1997 describes many of the rights of each partner and of creditors during creation, operation, or liquidation of the partnership Q15-3 The types of items that are typically included in the partnership agreement include: a The name of the partnership and the names of the partners b The type of business to be conducted by the partnership and the duration of the partnership agreement c The initial capital contribution of each partner and how future capital contributions are to be accounted for d A complete discussion of the profit or loss distribution, including salaries, interest on capital balances, bonuses, limits on withdrawals in anticipation of profits, and the percentages used to distribute any residual profit or loss e Procedures used for changes in the partnership such as methods of admitting new partners and procedures to be used on the retirement of a partner f Other aspects of operations the partners decide on, such as the management rights of each partner, election procedures, and accounting methods 15-1 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership Q15-4 (a) Separate business entity means that the partnership is a legal entity separate and distinct from its partners The partnership can own property in its own name, can sue, be sued, and can continue as an entity even though the membership of the partners changes with new admissions or with partner dissociations (b) Creditors view each partner as an agent of the partnership capable of transacting in the ordinary course of the partnership business Creditors may use this reliance unless the creditors receive a notification that the partner lacks authority for engaging in a specific type of transaction that would be used between the creditor and that partner The partnership should file a Statement of Partnership Authority to specifically state any limitations of authority of specific partners This voluntary statement is filed with the Secretary of State and the clerk of the county in which the partnership operates The Statement of Partnership Authority is sufficient notice to state a partner’s authority for real estate transactions (c) In the event the partnership fails and its assets are not sufficient to pay its liabilities, each partner has joint and several personal liability for the partnership obligations Each partner with a capital account that has a debit balance must make a contribution to the partnership to reduce the debit balance to zero These contributions are then used to settle the remaining amounts of the partnership liabilities If a partner fails to make the required contribution, then all other partners must make additional contributions, in proportion to the ratio used to allocate partnership losses, until the partnership obligations are settled Thus, a partner can be held legally responsible to make additional contributions to a partnership in dissolution if one or more other partners fail to make a contribution to remedy their capital deficits Q15-5 A deficiency in a partner's capital account would exist when the partner's share of losses and withdrawals exceeds the capital contribution and share of profits A deficiency is usually eliminated by additional capital contributions Q15-6 The percentage of profits each partner will receive, along with the allocation of $60,000 profit, is calculated as follows: Partner Partner Partner Percentage of Profits Profit to be Allocated Allocation 4/15 = 26.67% 6/15 = 40.00% 5/15 = 33.33% $60,000 $60,000 $60,000 $16,000 $24,000 $20,000 Q15-7 The choices of capital balances available to the partners include beginning capital balances, ending capital balances, or an average (usually weighted-average) capital balance for the period The preferred capital balance is the weighted-average capital balance because this method explicitly recognizes the time span each capital level was maintained during the period 15-2 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership Q15-8 Salaries to partners are generally not an expense of the partnership because salaries, like interest on capital balances, are widely interpreted to be a result of the respective investments and are used not in the determination of income, but rather in the determination of the proportion of income to be credited to each partner's capital account This treatment is based on the proprietary concept of owners’ equity that interprets salaries to partners as equivalent to a withdrawal in anticipation of profits Salaries are sometimes specified in the partnership agreement; however, in larger partnerships, salaries are typically determined by a partners’ compensation committee And also, under the old partnership law, a partnership was not an independent legal entity, but rather an aggregation of some of the rights of the individual partners With the advent of the UPA 1997 which defines a partnership as a separate legal entity, a theoretical argument could be made that salaries and capital interest paid to partners does cross the entity border and could be accounted for as a business expense Few partnerships need audited financial statements prepared in accordance with GAAP so the financial statement treatment of partners’ salaries has not been a major issue because the financial reporting for partnerships is more focused on meeting the information needs of the partners Q15-9 In most cases a partner’s dissociation does not result in the dissolution and winding up of the partnership The UPA 1997 provides for a process whereby the dissociating partner’s interest in the partnership can be purchased by the partnership The buyout price of a dissociated partner’s partnership interest is computed as the estimated amount that would have been distributable to the dissociating partner if the assets of the partnership were sold at the greater of the liquidation value or the value based on the sale of the entire business and the partnership was wound up, including payment of all partnership liabilities There are some specific events that cause dissolution and winding up of the partnership business These events are covered in Section 801 of the UPA 1997 and will be discussed at length in chapter 16 Students wishing to expand their understanding of dissolution are encouraged to examine Section 810 of the Act Q15-10 The book value of a partnership is the total value of the capital, which is also the difference between total assets and total liabilities The book value may or may not represent the market value of the partnership Q15-11 The arguments for the bonus method include preservation of the historical cost principle and the accounting principles stated in FASB 142 The arguments against the bonus method include a necessity for a fair valuation of the partnership assets and the new partner may dislike having a capital balance less than his or her investment in the partnership Q15-12 The new partner's capital credit is equal to the investment made when (1) the investment equals the proportionate present book value, (2) the assets of the partnership are revalued prior to admission of the new partner, or (3) goodwill is recognized for the present partners The new partner's capital credit is not equal to the tangible investment made when bonus is recognized or when goodwill is recognized for the new partner 15-3 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership Q15-13 Aabel's bonus is $3,000 ($20,000 x 15) if the bonus is computed as a percentage of income before the bonus Aabel's bonus is $2,608.70 [Bonus = 15($20,000 - Bonus)] if the bonus is computed as a percentage of income after deducting the bonus Q15-14 The implied fair value of the ABC partnership is $36,000 ($12,000 / 33333…) The entry the ABC partnership would make upon the admission of Caine follows Cash Goodwill [$36,000 - ($12,000 + $21,000)] Other Partners' Capitals Caine, Capital 12,000 3,000 3,000 12,000 Q15-15A The basis of Horton's contribution for tax purposes is $3,500 and is calculated as follows: $5,000 book value less ($2,000 assumed liability x 75) = $3,500 The basis of Horton's contribution for GAAP purposes is $8,000 and is calculated as follows: $10,000 market value less $2,000 assumed liability = $8,000 Q15-16B A joint venture is a short-term association of two or more parties to fulfill a specific project Corporate joint ventures are accounted for on the books of the investor companies by the equity method of accounting for investments in common stock 15-4 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership SOLUTIONS TO CASES C15-1 Partnership Agreement a The partnership agreement should be as specific as possible to avoid later differences of opinion In addition, the partnership agreement should be written as a formal agreement and signed by all partners The basic elements of a partnership agreement should include the following: The name of the partnership and the names of the partners The type of business to be conducted and the term, if any, of the partnership The initial capital contribution of each partner and the method(s) of accounting for future capital contributions The income or loss sharing procedures Procedures for changes in the partnership such as admission of new partners or retirements of present partners Any other specific procedures important to the partners b Salaries and bonuses to partners are part of the income distribution process regardless of how they are reported by the partnership Some partnerships prefer to report these within the partnership's income statement in order to compare the results of the partnership with other business entities c Not recording salaries and bonuses to partners in the income statement reflects the true nature of these items and reports income from the partnership before any distributions Thus, the income statement reflects the total profit to be distributed to the partners d The partnership agreement should state the following if interest is to be provided on invested capital: The capital balance to be used as the base for interest: Beginning of period, average (simple or weighted) for the period, or ending-of-period balances The rate of interest to be paid, or the basis by which the rate is to be determined When interest is to be determined in the profit or loss distribution process For example, should salaries and bonuses be added to the capital accounts before interest is computed? 15-5 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership C15-2 Comparisons of Bonus, Goodwill, and Asset Revaluation Methods MEMO to BGA Partnership: This memo discusses the three alternative methods of accounting for the admission of Newt, a new partner To state the present positions, Bill favors the bonus method, George favors the goodwill method, and Anne favors the revaluation of existing tangible assets First, all three methods are used in practice to account for the admission of a new partner The bonus method is a realignment of present partnership capital No additional capital, beyond the tangible investment of the new partner, is created in the admission process Some partners prefer this approach because it immediately states the proper capital relationships on the admission of the new partner and does not require the write-up of assets The goodwill method results in the recognition of goodwill, either the goodwill generated by the prior partners during the existence of the old partnership, or the goodwill being contributed by the new partner Goodwill is subject to an impairment test under the provisions of Statement of Financial Accounting Standards No 142, “Goodwill and Other Intangible Assets.” Any future impairment loss recognitions will affect all partners’ capital accounts in proportion to their profit and loss sharing ratios in the future periods as goodwill impairments are recognized If new partners are allowed into the partnership, or a present partner withdraws, the effect on each partner's capital account will be different than if the bonus method is used New partners will have to share in the write-off of goodwill, even goodwill created before a new partner's admission The revaluation of existing assets could be done under either of the two above cases This provides for the proper recognition of the assets and the distribution of any holding gain to the partners who were part of the partnership while the market increase took place For example, the assets could be revalued to their market value on the basis of appraisals and then the bonus or goodwill method could be used This would preclude a new partner from sharing in the holding gain that was appreciated before the new partner's admission The final decision must be made by the partners All partners should agree to the specific method, or methods, to be used to account for the admission of Newt The decision should be formalized, written, and signed by all partners 15-6 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership C15-3 Uniform Partnership Act (1997) Issues This solution uses the Uniform Partnership Act of 1997 (UPA 1997) for its references This Act is available on the World Wide Web and can be found using most internet browsers a Section 301 of the UPA 1997 specifies that every partner does have the right to act as an agent of the partnership for carrying on in the ordinary course the partnership business, unless the partner has in fact no authority to act for the partnership in the particular manner, and the person with whom the partner is dealing has knowledge of the fact that the partner has no such authority b Section 306 of the UPA 1997 specifies that a new partner is not personally liable for any partnership obligation incurred before the person’s admission as a partner But, the new partner may still lose the capital contribution made to be admitted to the partnership The key point is that the new partner is not at risk beyond the capital contribution made for admission c Section 403 of the UPA 1997 specifies that each partner, their agents and attorneys, may inspect the partnership’s books and records, and copy any of them, during normal business hours d Section 406 of the UPA 1997 specifies that if the initial term of the partnership is completed, and the partnership continues, the rights and duties of the partners remain the same but the partnership is now viewed as a partnership at will A partnership at will means that the partners are not committing to a term of time or to a project A partner in a partnership at will has more legal protection from possible damages from the other partners if he or she wishes to dissociate from the partnership A new partnership agreement is not needed for the continuation, but is a good idea to make sure that all continuing partners are in agreement with the ongoing partnership efforts e While it is very easy to form a partnership, it is not easy to simply leave a partnership Sections 601 through 603 of the UPA 1997 discuss a partner’s dissociation and its effect on the partnership A partner expressing the request to no longer be in the partnership may be subject to damages from a wrongful dissociation This suggests that the initial partnership agreement should include any specific provisions on resignations of partners if the partners feel the UPA’s guidelines are not sufficient for their partnership f The items to be included in the partnership agreement are dependent upon the wishes of the initial partners The partnership agreement should include any items that the partners want to reach agreement on as a basis of the partnership, its operations, and its possible future dissolution It is better to have agreement on many of the difficult items “up front” rather than ignoring them and then having them turn into large problems later on If an item is not included in the partnership agreement, then the state’s laws on partnerships regulate the rights and responsibilities of the partners and the rights of third-parties, including creditors There are some nonwaivable provisions of the UPA 1997 as presented in Section 103 of the Act A partnership agreement may not reduce or change any of the rights and responsibilities stated in Section 103 15-7 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership C15-4 Reviewing the Annual Report of a Limited Partnership The following answers are based on the 2006 10K of the limited partnership However, you may continue to use this case in other years by updating the data a Items and of the 2006 10-KSB state that Riverside Park Associates LP is an operator of apartment buildings (SIC 6513) The entity was formed on May 14, 1986, and it operates and holds an investment in the Riverside Park apartment complex located in Fairfax County, Virginia There are 1,229 units in the apartment complex b Items and state that the general partner is AIMCO/Riverside Park Associates GP, LLC AIMCO is the abbreviation for Apartment Investment and Management Company AIMCO GP is a wholly owned subsidiary of AIMCO/Bethesda, an affiliate of AIMCO which is a publicly traded real estate investment trust Initially, the general partner made a capital contribution of $99 and an additional $47,532,600 in capital was raised by the sale of 566 units of limited partnership interest The general partner, or agents retained by the general partner, performs management and administrative services for the limited partnership c Item 11 states that AIMCO Properties LP and AIMCO IPLP, LP, both affiliates of AIMCO, together own 383.41 of the 566 units of limited partnership interest, or 67.74 percent of those outstanding This means that the general partner and its affiliates are the majority owners of the limited partnership d Item includes the financial statements and footnotes The December 31, 2006, balance sheet reports partners’ deficits in the following amounts (in thousands): General partner, $(1,510); and Limited partners, $(20,638), for a total partner deficit of $(22,148) The deficits are a result of total liabilities, particularly mortgage notes, exceeding total assets The Statements of Changes in Partners’ Deficits show that the partners’ capital accounts were initially $47,533,000 but have been decreased because of operating losses A deficit in partnership capital could also arise if cash distributions to partners exceeded income For many limited partnerships, the investors receive a share of operating losses that they can report on their own income taxes, and receive cash distributions in excess of the losses In 2005 and 2006, the partnership did not make any cash distributions to the partners, but the 10Ks for prior years show that the partners received cash distributions in excess of the loss for those years This is typical for real estate entities and is one of the main reasons that investors acquire the limited partnership units of these entities The real estate assets provide the collateral for mortgages payable and the partners not have to provide much in investment capital once the mortgage is obtained e In the 2006 10-KSB, Note E, in Item Financial Statements, reports that the affiliates of the general partner charged the partnership for reimbursement of administrative expenses in the amounts of $1,157,000 and $595,000 for the years 2006 and 2005, respectively The limited partnership has no employees and depends on the general partner and its affiliates for management and administration of the partnership’s activities An analysis of these costs shows the following: 15-8 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership C15-4 (continued) Item 2006 Total amount charged to partnership by affiliates $595,000 Less amount capitalized to capital improvements (78,000) Less amount capitalized to redevelopment project (570,000) Equals the amount charged to administrative expenses $ 509,000 2005 $1,157,000 (10,000) (124,000) $461,000 The Statements of Operations report the $509,000 and $461,000 in general and administrative expenses, along with some other costs of the partnership The capitalized costs are added to the appropriate asset in Investment property f In the 2006 10-KSB, Note A of Item 7, Financial Statements, reports that, “Profits, losses and cash flow from normal operations are allocated 3% to the General Partner and 97% to the limited partners After distribution of certain priority items, Partnership residuals will be distributed 25% to the General Partner and 75% to the limited partners.” This profit and loss allocation ratio is consistent with the fact that the limited partners contributed virtually all the initial financing The affiliates acquired a total of 67.74 percent of the limited partnership units and these affiliates are indirectly controlled by AIMCO, the general partner 15-9 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership C15-5 Defining Partners’ Authority TO: Cathy RE: Authority of partners to engage in transactions Your partnership will be regulated by our state’s laws on partnership Our state has enacted the provisions of the Uniform Partnership Act of 1997 (UPA 1997) which is the most recent model act on partnership laws The UPA 1997 states, in its Section 301, that, “Each partner is an agent of the partnership for the purpose of its business An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.” This means that each partner can bind the partnership for transactions that would be expected to take place in the type of business in which the partnership would be engaged The issue of notice to third parties is important Section 303 of the UPA 1997 encourages all partnerships to file a Statement of Partnership Authority with the Secretary of State and also place a copy with the county clerk This statement lists the specific authorities for partners and the Act specifies that the filed statement is sufficient notice for partners engaging in partnership real estate transactions However, the statement of authority is not sufficient notice for other types of transactions For these other types of transactions, such as purchasing items from suppliers, ordering goods online, or acquiring equipment for the business, suppliers may presume any partner has the authority to transact unless that supplier is given notification of a restriction on a partner’s authority to that supplier This notice is best provided by written statement But this may be difficult to on a proactive basis because you may not know with whom an individual partner is transacting in the partnership’s name You should also require that the specific authority of each partner be specified in the partnership agreement If a partner breaches that agreement, you will have legal recourse against the partner, but that would mean seeking a legal judgment for that breach That would take time and involve costs You should have a frank and open discussion with both Adam and Bob expressing your concerns If they are not interested in working with you to find ways to alleviate your concerns and take actions to avoid potential future problems of the nature you discuss, then it may be best for you not to become a partner in the business If agreements cannot be worked out prior to the formation of a partnership, it is highly doubtful they will be worked out after the partnership is formed Once you are in a partnership it may be difficult and costly to dissociate (leave) the partnership There are online sources of examples of partnership agreements, the Uniform Partnership Act of 1997, a Statement of Partnership Authority, and you can find our state’s partnership regulations through our Secretary of State’s website I urge you to be sure to satisfy your concerns before you enter the partnership Joining a partnership is a significant decision that involves potential personal liability for the partnership’s obligations, including those incurred by the other partners Alternative business forms are available such as incorporating, for which you should consult with an attorney who has had experience in working with small business corporations 15-10 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-14 Division of Income a Distribution of $64,260 net income: Average capital for Luc Date Debit 1/1 4/1 8/1 Total $15,000 Credit Balance $ 5,000 $50,000 55,000 40,000 Months Maintained 12 $150,000 220,000 200,000 $570,000 Average capital ($570,000 / 12 months) Date Debit 1/1 7/1 9/1 Total $10,000 $ 47,500 Average capital for Dennis Months Credit Balance Maintained $70,000 60,000 82,500 $22,500 12 $ 72,500 Luc Profit ratio Average capital Net income Salary Interest on average capital (10%) Bonusa Residual income Allocate 3:2 Total Bonus B 20B 21B B = = = = = 05(Net Income - Bonus) 05($64,260 - B) $64,260 - B $64,260 $3,060 15-39 Months x Dollar Balance $420,000 120,000 330,000 $870,000 Average capital ($870,000 / 12 months) a Months x Dollar Balance Dennis $47,500 $72,500 $24,000 4,750 3,060 $28,000 7,250 (1,680) $30,130 (1,120) $34,130 Total $ 64,260 (52,000) (12,000) (3,060) $ (2,800) 2,800 $ -0- Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-14 (continued) b Distribution of $108,700 income: Profit ratio Ending capital balance after deducting salaries of $24,000 for Luc and $28,000 for Dennis Net income Salary Interest on ending capital balance (10%) Bonusa Residual income Allocate 1:1 Total a Bonus B 12.50B 13.50B B c = = = = = Luc Dennis Total 1 $16,000 $54,500 $24,000 $28,000 1,600 4,200 5,450 22,725 $52,525 22,725 $56,175 (7,050) (4,200) $ 45,450 (45,450) $ -0- Dennis Total $108,700 (52,000) 08(Net Income - Bonus - Salaries) 08($108,700 - B - $52,000) $56,700 - B $56,700 $ 4,200 Distribution of $76,950 income: Luc Profit ratio Beginning capital balance Net income Salary Interest on beginning capital balance (10%) Bonusa Residual income Allocate 4:2 Total a Bonus B 8B 9B B = 125(Net Income - Bonus) 125($76,950 - B) $76,950 - B $76,950 $8,550 15-40 $50,000 $70,000 $24,000 $28,000 5,000 8,550 7,000 2,933 $40,483 1,467 $36,467 $ 76,950 (52,000) (12,000) (8,550) $ 4,400 (4,400) $ -0- Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-15 Withdrawal of a Partner under Various Alternatives a Spade's capital interest was acquired in a personal transaction with Jack Spade, Capital Jack, Capital b 120,000 120,000 Amount paid by Jack for Spade's capital interest Recorded amount of Spade's capital interest Goodwill attributable to Spade Spade's share of profits/losses Implied value of the partnership's goodwill ($30,000 / 50) – allocated to all partners in the ratio 20:30:50 Goodwill Ace, Capital (.20 x $60,000) Jack, Capital (.30 x $60,000) Spade, Capital (.50 x $60,000) $ 60,000 60,000 12,000 18,000 30,000 Spade, Capital ($120,000 + 30,000) Jack, Capital c $ 150,000 (120,000) $ 30,000 50% 150,000 150,000 The partnership paid a bonus to Spade upon retirement Total capital of the partnership after Spade's retirement was $290,000 Amount paid to Spade upon retirement Spade's capital credit Bonus paid to Spade — allocated to Ace and Jack in the ratio 40:60 Spade, Capital Ace, Capital (.40 x $60,000) Jack, Capital (.60 x $60,000) Cash $ 180,000 (120,000) $ 60,000 120,000 24,000 36,000 180,000 Capital balances after retirement: Ace, Capital ($150,000 - $24,000) Jack, Capital ($200,000 - $36,000) Total capital $ 126,000 164,000 $ 290,000 15-41 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-15 (continued) d Spade was given cash and land Capital of the partnership after Spade's retirement was $310,000 Profit ratio Capital balances before Spade's retirement Gain recognized on transfer of land to Spade ($120,000 minus $100,000) Capital balances after allocation of gain Ace 20% Jack 30% Spade 50% $150,000 $200,000 $ 120,000 4,000 6,000 10,000 $154,000 $206,000 $ 130,000 Amount paid to Spade ($60,000 cash and $120,000 land) Spade's capital interest — see above schedule Bonus to Spade allocated between Ace and Jack in the ratio 40:60 Land Ace, Capital (.20 x $20,000) Jack, Capital (.30 x $20,000) Spade, Capital (.50 x $20,000) Spade, Capital Ace, Capital (.40 x $50,000) Jack, Capital (.60 x $50,000) Cash Land $ 180,000 (130,000) $ 50,000 20,000 130,000 20,000 30,000 Capital balances after Spade's retirement: Ace, Capital ($154,000 - $20,000) Jack, Capital ($206,000 - $30,000) Total capital e 4,000 6,000 10,000 60,000 120,000 $ 134,000 176,000 $ 310,000 Spade was given $150,000 upon retirement, and the goodwill attributable to Spade was recognized Amount paid to Spade Spade's capital interest Goodwill attributable to Spade $ 150,000 (120,000) $ 30,000 Spade, Capital Goodwill Cash 120,000 30,000 15-42 150,000 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-15 (continued) f Spade was given $150,000 upon retirement, and goodwill applicable to the entire business was recorded Amount paid to Spade Spade's capital interest Goodwill attributable to Spade Spade's share of profits/losses Goodwill attributable to the entire partnership $30,000/.50 — allocated to all the partners in the ratio 20:30:50 Goodwill Ace, Capital (.20 x $60,000) Jack, Capital (.30 x $60,000) Spade, Capital (.50 x $60,000) Spade, Capital Cash g $ 150,000 (120,000) $ 30,000 50% $ 60,000 60,000 12,000 18,000 30,000 150,000 150,000 Spade was given land and a note payable upon retirement Capital of the partnership after Spade's retirement was $360,000 Ace Profit ratio 20% Capital balances before Spade's retirement $150,000 Allocation of gain on transfer of land ($100,000 - $60,000 = $40,000) 8,000 Capital balances before Spade's retirement, adjusted for gain $158,000 Amount paid to Spade ($100,000 of land + $50,000 note) Spade's capital interest — adjusted Bonus given to Spade — allocated between Ace and Jack in the ratio 40:60 Land Ace, Capital (.20 x $40,000) Jack, Capital (.30 x $40,000) Spade, Capital (.50 x $40,000) Spade, capital Ace, Capital (.40 x $10,000) Jack, Capital (.60 x $10,000) Land Note Payable Jack 30% Spade 50% $200,000 $ 120,000 12,000 20,000 $212,000 $ 140,000 $ 150,000 (140,000) $ 10,000 40,000 140,000 4,000 6,000 15-43 8,000 12,000 20,000 100,000 50,000 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-15 (continued) Capital balances after Spade's retirement: Ace, Capital ($158,000 - $4,000) Jack, Capital ($212,000 - $6,000) Total capital P15-16 $154,000 206,000 $360,000 Multiple Choice Questions — Initial Investments, Division of Income, Admission and Retirement of a Partner [AICPA Adapted] d The contribution of noncash property into a partnership should be recorded by crediting the partner's capital account for the fair value of the property contributed In effect, the partnership is acquiring the property from the partner at its fair value b The capital balances of William and Martha at the date of partnership formation are determined as follows: Cash Inventory Building Furniture and equipment Total Less mortgage assumed by partnership Amounts credited to capital d c William $20,000 15,000 $35,000 Martha $ 30,000 15,000 40,000 $ 85,000 $35,000 (10,000) $ 75,000 Total of old partners' capital Investment by new partner Total of new partnership capital Capital amount credited to Johnson ($95,000 x 20) $ 80,000 15,000 $ 95,000 $ 19,000 The capital balances of each partner are determined as follows: Apple $50,000 Cash Property Mortgage assumed Equipment Amount credited to capital accounts $50,000 15-44 Blue $ 80,000 (35,000) $ 45,000 Crown $ 55,000 $ 55,000 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-16 (continued) d Because both partners have equal capital balances, Norbert's capital has to be increased to equal that of Moon's Since Moon's capital balance is $60,000 and Norbert's is $20,000, an additional $40,000 has to be credited to Norbert's capital to make it equal Moon's capital This additional amount credited to Norbert's capital is the goodwill that Norbert is bringing to the partnership a Moon's share of the net income of $25,000 is 60%, or $15,000 d Crowe and Dagwood are getting a bonus from Elman, since the amount of Elman's investment into the partnership exceeds the amount credited to Elman's capital account The bonus should be allocated to Crowe and Dagwood in their respective profit and loss ratio before the admission of Elman—–the old profit and loss ratio b The net income of $80,000 is allocated to Blue and Green in the following manner: Salary allowances Remainder Allocation of the negative remainder in the 60:40 ratio Allocation of net income c Blue Green $ 55,000 $45,000 (12,000) $ 43,000 (8,000) $37,000 Net Income $ 80,000 (100,000) $ (20,000) $ 20,000 -0- Jill received a bonus when she retired from the partnership The bonus is being given to Jill by Bill and Hill, which means that the bonus is allocated to Bill's and Hill's capital accounts in their respective profit and loss sharing ratio 15-45 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-17 Partnership Formation, Operation, and Changes in Ownership a Entries to record the formation of the partnership and the events that occurred during 20X7: Cash Inventory Land Equipment Mortgage payable Installment Note Payable Jordan, Capital ($60,000 + $80,000 + $100,000 - $20,000) O’Neal, Capital ($50,000 + $130,000 - $50,000) 110,000 80,000 130,000 100,000 220,000 130,000 (1) Inventory Cash Accounts Payable (2) Mortgage Payable Interest Expense Cash 5,000 2,000 Installment Note Payable Interest Expense Cash 3,500 2,000 (3) (4) 30,000 Accounts Receivable Cash Sales 21,000 134,000 (5) Selling and General Expenses Cash Accrued Expenses Payable 34,000 (6) Depreciation Expense Accumulated Depreciation 6,000 (7) Jordan, Drawing ($200 x 52) O’Neal, Drawing Cash 10,400 10,400 (8) Sales Income Summary 155,000 15-46 50,000 20,000 24,000 6,000 7,000 5,500 155,000 27,800 6,200 6,000 20,800 155,000 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-17 (continued) (9) Cost of Goods Sold Inventory $90,000 = $80,000 beginning inventory + 30,000 purchases - 20,000 ending inventory 90,000 Income Summary Cost of Goods Sold Selling and General Expenses Depreciation Expense Interest Expense 134,000 Income Summary Jordan, Capital O’Neal, Capital 21,000 Jordan, Capital O’Neal, Capital Jordan, Drawing O’Neal, Drawing 10,400 10,400 90,000 90,000 34,000 6,000 4,000 10,500 10,500 10,400 10,400 Schedule to allocate partnership net income for 20X7: Jordan 60% $220,000 Profit percentage Beginning capital balance Net income ($155,000 revenue - $134,000 expenses) Interest on beginning capital balances (3%) O’Neal 40% $130,000 Total 100% $350,000 $ 21,000 $ Salaries Residual deficit Total 15-47 6,600 $ 3,900 12,000 12,000 (8,100) $ 10,500 (5,400) $ 10,500 (10,500) $ 10,500 (24,000) $(13,500) 13,500 $ -0- Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-17 (continued) b Jordan — O’Neal Partnership Income Statement For the Year Ended December 31, 20X7 Sales Less: Cost of Goods Sold: Inventory, January Purchases Goods Available for Sale Less: Inventory, December 31 Gross Profit Less: Selling and General Expenses Depreciation Expense Operating Income Nonoperating Expense – Interest Net Income c $155,000 $ 80,000 30,000 $110,000 (20,000) $ 34,000 6,000 (90,000) $ 65,000 (40,000) $ 25,000 (4,000) $ 21,000 Jordan — O’Neal Partnership Balance Sheet At December 31, 20X7 Cash Accounts Receivable Inventory Land Equipment (net) Total Assets Liabilities: Accounts Payable Accrued Expenses Payable Installment Note Payable Mortgage Payable Total Liabilities Capital: Jordan, Capital O’Neal, Capital Total Capital Total Liabilities and Capital Assets $158,900 21,000 20,000 130,000 94,000 $423,900 Liabilities and Capital $ 6,000 6,200 16,500 45,000 $ 73,700 $220,100 130,100 15-48 350,200 $423,900 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-17 (continued) d Hill's investment into the partnership Prior partners' capital Total capital of the new partnership Hill's capital credit (.20 x $450,000) Bonus allocated to Jordan and O’Neal in the ratio 60:40 $ 99,800 350,200 $450,000 $ 90,000 $ 9,800 January 1, 20X8 journal entry: Cash Jordan, Capital (.60 x $9,800) O’Neal, Capital (.40 x $9,800) Hill, Capital 15-49 99,800 5,880 3,920 90,000 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-18A Initial Investments and Tax Bases [AICPA Adapted] a Entry to record initial investments using GAAP accounting: Cash Computers and Printers Office Furniture Library Building Notes Payable Mortgage Payable Delaney, Capital Engstrom, Capital Lahey, Capital Simon, Capital Record initial investments in DELS partnership b 50,000 18,000 23,000 7,000 60,000 25,000 36,000 32,000 22,000 15,000 28,000 Tax bases: Tax basis of assets contributed Add: Partner's share of other partners' liabilities assumed by the partnership: $36,000 from Delaney x 1/4 $10,000 from Engstrom x 1/4 $15,000 from Lahey x 1/4 Less: Partner's liabilities assumed by other partners: $36,000 x 3/4 $10,000 x 3/4 $15,000 x 3/4 Total Delaney Engstrom $40,000 2,500 3,750 (27,000) $ 19,250 15-50 Lahey Simon $26,000 $ 33,000 $26,000 9,000 9,000 2,500 9,000 2,500 3,750 3,750 (7,500) $31,250 (11,250) $ 33,250 $41,250 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-19 Formation of a Partnership and Allocation of Profit and Loss Part I: Haskins and Sells Partnership Balance Sheet At January 2, 20X3 Assets Current assets: Cash Temporary Investments Trade Accounts Receivable Less: Allowance for uncollectible accounts Note Receivable Inventories Total Current Assets $70,000 (4,500) Property, Plant, and Equipment: Building (less accumulated depreciation of $230,000) $ 55,000 81,500 65,500 50,000 62,500 $314,500 370,000 Intangible Assets: Customer Lists Total Assets 60,000 $744,500 Liabilities and Partnership Capital: Current Liabilities: Current Portion of Mortgage Payable $ 25,000 Long-term Liabilities: Mortgage Payable, less current portion 150,000 Partnership Capital: Haskins, Capital Sells, Capital $327,000 242,500 Total Liabilities and Partnership Capital 569,500 $744,500 15-51 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership P15-19 (continued) Part II: a Haskins and Sells Partnership Income Statement For the Year Ended December 31, 20X3 Revenues Less: Cost of Goods Sold Gross Profit Operating Expenses: Selling, General, and Administrative Expenses Net Income $ 650,000 (320,000) $ 330,000 (70,000) $ 260,000 Note that salaries paid to partners and the bonus paid to Haskins are distributions of partnership net income and are not expenses of the partnership b Description 10% bonus to Haskins Salaries to each partner Residual net income: $74,000 Total Haskins $ 26,000 90,000 14,800 $130,800 Sells $ 70,000 59,200 $129,200 Total $ 26,000 160,000 74,000 $260,000 c Description Capital balances, January 3, 20X3 Add: Net income for 20X3 Withdrawals made during the year Capital balances at December 31, 20X3 Haskins $327,000 130,800 (10,000) $447,800 Capital Sells $242,500 129,200 (5,000) $366,700 Total $569,500 260,000 (15,000) $814,500 d To find out what partnership net income would have to be for each partner to receive the same amount of income, determine the amount of income difference that would go to each partner for each additional dollar of partnership net income To illustrate, assume that partnership net income was $261,000 instead of $260,000 How would this incremental $1,000 affect the distribution of net income? To find out the answer to this question, see the computation below Description Bonus to Haskins Salaries to each partner Remainder to each partner ($74,900) Total Haskins $ 26,100 90,000 14,980 $131,080 Sells $ 70,000 59,920 $129,920 Total $ 26,100 160,000 74,900 $261,000 The increase of $1,000 in partnership net income resulted in a $280 increase in Haskins’ share of net income and a $720 increase in Sells’ share of net income Another way to look at this is that for a $1,000 increase in partnership net income, Sells will receive $440 more, or 44% more, than Haskins ($720 minus $280 = $440 divided by $1,000) 15-52 Chapter 15 - Partnerships: Formation, Operation, and Changes in Membership Take this information and use it to answer the question At partnership net income of $260,000, Haskins will receive $1,600 more net income than Sells ($130,800 minus $129,200) Take the difference between these two incomes and divide it by 44 Dividing $1,600 by 44 equals $3,636 Add this amount to $260,000 to get $263,636, the amount of partnership net income that would result in each partner receiving the same amount of net income 15-53 ... It is expected by the NCCUSL that more states will adopt the UPA 1997 over time because of the pressure by creditors and from the business community in general b Your advanced financial accounting... result in the dissolution and winding up of the partnership The UPA 1997 provides for a process whereby the dissociating partner’s interest in the partnership can be purchased by the partnership... statements regarding the financial position of the partnership You not want to misrepresent the correct financial position and be personally liable for potential future damages sought by the new partner